Asset Allocation is Crucial when Saving for Retirement

Ah, retirement; that period in our lives where we can do what we want, when we want. If you pay any attention to many of the financial services commercials that come on TV, we will all own vineyards, or racing our classic sports cars, and playing golf; all in some sunny idyllic place where the birds always sing. Sounds great right? Unfortunately the vast majority of us will more than likely have a retirement that is something a bit more down to Earth. Personally, I think owning a vineyard is cool, but sounds like a lot of work, and quite honestly, I subscribe to Mark Twain’s belief that playing golf is nothing but a good way to ruin a nice walk. If however, you are of the means to achieve any of those picturesque retirements, more power to you, and odds are, you probably can afford a money manager that pretty much handles your asset allocations with minimal work or research on your part. This is not to say that you have no input whatsoever, your financial adviser probably meets with you several times through the year to share investment ideas, and review your portfolio(s). After working in the financial industry for five years, one of the things I came away with is that typically the more money a client has the more attention they and their money gets, many of you probably already suspected this. This is not to say, if you don’t have a lot of money, that you should fire your current financial adviser, the vast majority of financial professionals are very attentive to ALL of their clients; and just because they may not meet with you as much as their higher net worth clients, it doesn’t mean your account is being ignored. What it does mean, is that you may have to do more of your own research, and take a little more control over your account(s). By control, I am not saying you have to manage your retirement accounts yourself, and dictate what you want done to your financial adviser. Though it is your money, so if that is what you want to do, then that is your prerogative; however it has also been my experience that the clients that do this tend to be wrong far more than they are right, thus losing money, or lagging in performance which is essentially losing money. Rather, try and stay informed with what is going on in the markets, and especially what investments you have in your portfolio(s). By staying informed, this enables you to ask appropriate and informed questions about your specific account(s) and the investments in them when talking to your financial adviser, and then listen to their recommendations. Notice I said listen, that still does not mean you have to do what is recommended, again it is your money; but you are more than likely paying this person a management fee, and managing money is their chosen profession, so odds are they know what they are talking about. This brings me to the asset allocation of your account(s), specifically your retirement account(s). While there is no perfect allocation that fits everyone, each of us have different needs, goals, and comfort levels, and your age will be a large factor in how your financial adviser recommends allocating your account(s). That being said, let’s just address some of the basics. There are three main asset classes, equities (stocks), fixed income (bonds), and cash and/or cash equivalents (think money market accounts). These are going to be the ones most of us will invest in, those that are a little more well-heeled may have investments in real estate, and collectables such as cars, art, Faberge’ Eggs, etc. etc. I am going to go out on a limb and guess that the vast majority of you don’t have these things, so we will focus on the three main asset classes. First we will talk about the one that most of know at least something about, and that is equities, or stocks. Regardless of your age, it is often recommended that there be some percentage of stocks in your account(s). The reason for this is historically speaking, stocks have outperformed or increased in value faster than other asset classes, and even out pacing the historical rate of inflation. Obviously, if you are a younger person, thus further from retirement, your allocation towards equities is going to typically be a greater percentage of your account(s) than other asset classes. Now, in the world of stocks there are subcategories, based on market capitalization (how big the company is), so there is further diversification that can be done within this asset class. These “sub classes” are Small Capitalization (Small Cap) stocks, which as the name implies are smaller companies. These stocks can be pretty volatile, moving up or down quickly, and thus are considered a little risky. Younger investors will tend to invest a larger portion of their accounts in these types of stocks. Then there are Mid-Caps, which not surprisingly are the stocks of companies that lie in the middle of the spectrum of company size. Again these stocks can be more volatile and thus are considered slightly more risky. Third is the Large Caps, these are the big boys, and many of them are what are referred to as “blue chips,” think Coca Cola, and Wal-Mart as a couple of examples. While still prone to large movements, these stocks can tend to be fairly steady and often times pay dividends which can either be reinvested in the stock, or taken as income; as such many older investors may skew their equity weightings towards large caps in order to receive the dividends as a form of supplemental income. It is important that you talk with your financial professional regarding to what weighting you should have in stocks, and what weightings are appropriate for you in small, mid, and large caps; as well as the tax consequences the dividends may have on you and your account(s). Next is fixed income, or bonds; which are a bit enigmatic to the average investor. Bonds are, in the simplest definition, debt that is sold with the promise to pay the buyer interest and then at the bonds maturity pay they buyer the face value of that bond. Bonds are typically sold in varying maturities, and can be bought and sold between entities prior to their maturity. This overly simplistic, and I recommend further research into the subject. Bonds too have different classifications, there are corporate bonds, which not surprisingly are bonds issued by corporations, again like Coca Cola, and Wal-Mart. Then there are municipal bonds, this are bonds issued by municipalities and states, and then there are federal bonds, or treasuries as they are commonly referred to. Younger investors may not own a single bond in their account(s), while older investors’ accounts may own a substantially larger percentage of bonds, wanting the interest payments that they provide to further supplement their income, so they can support themselves better, and maybe afford to race their classic sports car on the weekends. Each class of bonds has different tax consequences, and consulting your financial adviser about these is highly recommended. Bonds also have what is called interest rate risk, which your adviser should be able to explain to you too. Finally there is cash or cash equivalents. We all know what cash is, so I will not give an explanation. A cash equivalent however does deserve some explanation. Quite simply cash equivalents is your cash being held in a money market account, which is kind of a liquid (easily bought and sold) mutual fund, that typically has a higher interest rate than your run of the mill savings account. Cash and Cash equivalents is almost always the smallest portion of any account, regardless of a person’s age. This is because growth in this asset class tends to be excruciatingly slow, and interest rates tend to be substantially lower than many bonds and even some stocks. None-the-less you will probably have at least some minute amount of cash in your account(s) due to dividends and or interest received from bonds and the cash/money market account itself. Again, I can’t emphasize this enough, please speak with your financial adviser about your specific investment needs, they should be able run financial models on various allocations that can give you a better picture as how you may want to allocate your account(s) to better realize the retirement of your dreams, be it owning a vineyard, or simply piddling away in your backyard garden in your golden years.